What Goldman's ICBC Sale Says About Chinese Banks

The news should worry anyone long on China’s banking sector. After all, it’s not often that Goldman is willing to offload anything for 2.5 percent less than recent market rates, which is what its $1.1 billion sale of ICBC shares amounts to.

A number of indicators show that Chinese banks might be slightly rotten, or at least overripe. Last quarter was the sixth straight period in which non-performing loans climbed in the country, according to a report from the China Banking Regulatory Commission. Meanwhile, Chinese lenders are sweetening deals in the face of competition. Among the nation’s 3,800 lenders (of which ICBC is the largest), net interest margin fell to 2.57 percent in the first quarter, from 2.75 percent in the preceding period.

The sheer pace of economic growth in recent years could cover up a lot of fishy loans—say, when a government official quietly recommends that a certain bank get behind a certain building project, regardless of its credit worth. But growth is slowing in China, which has sparked a lot of grumbling about shifty builders and unviable developments.

Last month, Moody’s (MCO)lowered its outlook on China credit, citing a surge in lending by unregulated shadow banks and the tendency of legitimate banks to shuffle troubled assets off balance sheets. That kind of accounting sleight-of-hand poses systemic risk to companies such as ICBC, Moody’s said.

In fact, Goldman may have timed its China foray perfectly. The latest sale represents the sixth and final time it has offloaded a chunk of ICBC stock. Goldman first bought into the bank in early 2006, snapping up a 5 percent stake for $2.6 billion. Just a few months later, ICBC raised $21.9 billion in a massive initial public offering, simultaneously listing shares on the Hong Kong and Shanghai stock exchanges.

At the time, Chinese banks, like Porsches (PAH3:GR) and polo ponies, were fashionable assets for Wall Street chiefs. They were a way to take a long position on China’s burgeoning economy while also getting a toehold in a tight banking market closely controlled by the government. The theory was: Western banks that had some skin in the game would be in a good position to snag lucrative work advising and underwriting as the country slowly opened its doors to international investment bankers.

UBS (UBS) and Royal Bank of Scotland (RBS:LN) both bought into ICBC, though they sold those stakes during the financial crisis to bolster capital.

It’s questionable how much piecework the U.S. and European banks were able to grab. In 2006, Goldman Sachs was the No. 2 investment bank in China, with 9.4 percent of the market by revenue, according to Dealogic. Last year, it barely broke the top 10 and grabbed less than 3 percent of the spoils from selling stocks, bonds, and advisory services in China. As Chinese firms have grown in that time, they’ve showed a tendency to close ranks on outside firms and share business with domestic rivals.

Goldman declined to detail the size of its China business, saying only that the ICBC partnership was a strategic success and allowed the bank to gain a lot of expertise about the Chinese market. In truth, it might have gleaned the most valuable information possible: when to bail out.